For Greece, no fine deals, just ugly choices

By Megan Greene

A prostrate country struggles to work out what ‘yes’ and ‘no’ mean.

ATHENS — Greece has been facing bad options since 2010 when it signed up to its first bailout package: implement the terms demanded by creditors — undermining growth and decimating living standards — or risk exiting the eurozone.
This has only become truer as Greece’s overall debt burden has grown and economic growth has disappeared. Never has Greece faced such difficult choices as it does on July 5 in a referendum. While none of the options are good, Greeks should strive to choose the least bad one and vote “yes.”

What is the referendum on?

Officially, the referendum has been scheduled on Sunday for voters to choose whether to accept (“yes”) or reject (“no”) the latest proposal from the creditors for the extension of Greece’s second bailout package. But there is one hitch: the second bailout expires on Tuesday, June 30, and with it the creditors’ proposal. This has left most Greeks with whom I’ve spoken in Athens confused about what exactly a yes or no vote means.
 Given that Greeks will be weighing in on a moot point, the narrative of the referendum is still up for definition. The government has recommended that people vote no in the referendum. It is trying to frame the vote as a choice between standing up to Greece’s exploitative creditors (no) or caving and surrendering all dignity (yes). The “yes” lobby is trying to frame the referendum as a choice between eurozone exit (no) or eurozone membership (yes). 
With only a week to campaign, neither side has much time to make its narrative the prevailing one. But the prevailing narrative is crucial in determining the outcome of the referendum. If the government’s narrative wins, a no vote is likely. If Greeks feel they are voting for or against eurozone membership, a yes vote is likely. The vote will likely be split across age, class and party lines. The outcome itself is uncertain; the only certainty is that it will be close.

NAI (“yes”)

If the yes vote wins, there is a big question mark surrounding what exactly this will mean given that the proposals on which Greeks are voting will have expired. As with many other things in this Greek crisis, the implications are more likely to be focused on politics than on specific proposals and exact sums of savings generated.
 If Prime Minister Alexis Tsipras maintains his no stance on the referendum and the yes vote wins, he may have little choice but to resign. The leader of the next biggest party, New Democracy (ND), would be given a mandate to form a government by the president. It seems most likely a government of national unity would emerge.
 This would be good news in the eyes of the creditors. Tsipras alienated his only ally in the negotiations, German Chancellor Angela Merkel, when he announced the referendum. Merkel is unlikely to trust the current greek government to implement any deal.
 Even if a new government reopens the prospect of a bailout deal for Greece, the terms of any deal could necessarily be worse than the proposal currently on the table, given that the Greek economy and (crucially) tourism revenues will be down significantly by then. Any fiscal adjustment to put Greece on a fiscal path acceptable to the creditors will be swingeing.

OXI (“no”)

If voting yes for the prospect of a bailout deal that will involve draconian austerity measures sounds bad, consider the alternative. A no vote in the referendum will most likely result in “Grexit.”
 One potential trigger for a Greek exit from the eurozone could be social unrest. Greek civil servant wages are paid in the middle and at the end of each month, and pensions are paid at month-end. The Greek government does not have any remaining funding for public sector wages and pensions next month. The Tsipras government could pay civil servants in IOUs or a parallel currency for a while, but eventually public sector workers may revolt and demand to be paid in a currency with which they can also pay their taxes.
 IOUs or a parallel currency are also insufficient because of the state of Greece’s banks. Without even the prospect of a deal for Greece, the ECB will likely turn up the heat on Greece — particularly once Greece defaults on repayments of debt to the ECB on July 20. The ECB will most likely do this by raising the haircuts on Greek government-backed collateral. 
Once the ECB determines that some Greek banks are insolvent, it will also shut down emergency liquidity assistance (ELA) for them, forcing those banks to come up with resolution programs. The problem is that Greece does not have the funds available to recapitalize its banks, let alone resolve them. To do either one, Greece needs a legal tender of its own, at which point it will no longer be part of the euro system or “Target2” balances.

Does Grexit Matter?

So far, contagion from this latest escalation in the Greek crisis has been muted. Currency and government bond movements have not been dramatic, and the former have largely reverted over the course of Monday. But don’t let the markets lull you into a false sense of security. A Grexit might not have an immediate dramatic impact on Europe, but the impact will be felt eventually. 
If Greece leaves the eurozone, the currency area will likely become a currency peg. The next time there is a cyclical downturn in Europe, Italy — with a much larger debt burden — could get into trouble from both a growth and a debt sustainability standpoint. The temptation to leave the eurozone and benefit from a nominal devaluation will be significant, particularly among export-oriented manufacturers in northern Italy. 
The ECB will be able to intervene to reduce upward pressure on Italian government borrowing costs temporarily, but it cannot buy up as much Italian debt as it wants, whenever it wants; the ECB is beholden to its capital key. As investors realize that the ECB is at its limits of purchasing Italian bonds, contagion will be expected to return with a vengeance. An exit by a small economy like Greece may not bring down the eurozone immediately, but an exit by a large country may well do so.